In 2003, KPMG settled the claims against it in the Rite Aid securities litigation for $125 million. As reported in The 10b-5 Daily, a class member objected to the payment of 25% of that sum (i.e., $31 million) in attorneys' fees. The district court approved the settlement terms despite the objection and an appeal followed.
According to an article (via law.com - free regist. req'd) in the Legal Intelligencer, the U.S. Court of Appeals for the Third Circuit has held that the district court should reconsider its fee award. The district court correctly applied the percentage-of-recovery approach, but erred in its application of a lodestar 'crosscheck' by focusing only on the hourly rates for the top lawyers handling the case, making the fee award appear more reasonable. The court found: "Had the hourly rates been properly blended, taking into account the approximate hourly billing rates of the partners and associates who worked on the case, the multiplier would have been a higher figure, alerting the trial court to reconsider the propriety of its fee award."
It is important to note, however, that the court also rejected the argument that courts should be required to apply a sliding scale and reduce the percentage of a settlement going to attorneys' fees based on the size of the fund. The opinion can be found here.
Whether and how to apply the fraud-on-the-market theory (i.e., reliance by investors on an alleged misrepresentation is presumed if the company's shares were traded on an efficient market) to research analyst statements continues to be controversial.
In DeMarco v. Lehman Brothers, 222 F.R.D. 243 (S.D.N.Y. 2004), a case alleging that a Lehman analyst made buy recommendations for RealNetworks, Inc. stock while secretly holding negative views of the stock, Judge Rakoff denied the motion for class certification based on the plaintiffs' inability to provide sufficient evidence that the fraud-on-the-market theory was applicable. The court noted that there is a "qualitative difference" between a statement of fact from an issuer and a statement of opinion by a research analyst. In particular, a "well-developed efficient market can reasonably be presumed to translate the former into an effect on price, whereas no such presumption attaches to the latter." As a result, the court held that the fraud-on-the-market doctrine can apply to a case based on research analyst statements "only where the plaintiff can make a prima facie showing that the analyst's statements materially impacted the market price in a reasonably quantifiable respect."
Another district judge in the S.D.N.Y., however, has disagreed with that standard and granted class certification in a similar case. In DeMarco v. Robertson Stephens, 2005 WL 12033 (S.D.N.Y. Jan. 20, 2005), Judge Lynch addressed a case alleging that a Robertson Stephens' analyst and certain corporate officers maintained a buy rating on Corvis Corp. stock while privately selling their own holdings. (An earlier post on the case can be found here). In determining whether the fraud-on-the-market theory could be applicable, the court "decline[d] to adopt a higher standard at class certification for plaintiffs alleging securities fraud by research analysts and their employers." The court found that "by presenting a mix of market activity evidence, logical arguments, and statistical studies of the influence of at least some analyst statements, plaintiffs have made 'some showing' of their ability to make a common legal and factual presentation on reliance to an eventual factfinder."
The Second Circuit has come close to deciding this issue before, only to be thwarted by a settlement. It may get another chance.
Addition: The New York Law Journal has an article (via law.com - free regist. req'd) on the decision.
TXU Corp. (NYSE: TXU), a Dallas-based energy company, has announced the preliminary settlement of the securities class action pending against the company in the N.D. of Tex. The case was originally filed in Oct. 2002 and alleges that the company misled investors about its financial performance. The settlement is for $150 million, with at least $66 million to be paid by TXU's insurers, and also includes certain corporate governance reforms.
Did The 10b-5 Daily's summary of the Dura Pharmaceuticals v. Broudo oral argument get it right? Here's a chance to find out: the U.S. Supreme Court has posted the transcript. Thanks to Richard Zelichov for pointing out the link.
Securities Litigation Watch has an interesting post on the recent series of suits by mutual fund investors alleging that the funds failed to collect as much as $2 billion in securities class action settlement payouts to which the investors were entitled.
The U.S. Senate is set to pass the Class Action Fairness Act. The legislation applies some of the reform concepts in the PSLRA and SLUSA to all class actions. Notably, class actions meeting certain jurisdictional criteria would have to be heard in federal court. Reuters reports that the Senate floor debate may take place the week of Feb. 7.
At the same time, proponents of U.S. class action reform are urging France not to permit these types of suits. Jacques Chirac, France's president, announced earlier this year that he had asked his government to propose legislation allowing collective suits against companies. An article in today's Financial Times discusses comments made by the president of the U.S. Chamber of Commerce on a trip to Paris, where he warned France that U.S.-style class actions "would damage the economy and shift money from 'good companies to lawyers.'"
ImClone Systems, Inc. (NASDAQ: IMCL), a New York-based biopharmaceutical company, has announced the preliminary settlement of the securities class action pending against the company in the S.D.N.Y. The case was originally filed in 2002 and alleges that the company made false or misleading statements regarding the prospects for FDA approval of its Erbitux cancer drug. The events surrounding the case are probably best known for leading to Martha Stewart's conviction for lying to federal investigators about her sale of ImClone shares. The settlement is for $75 million.
The general theme of the research analyst cases is straightforward: the defendants allegedly committed fraud by disseminating research reports that they knew to be overly optimistic. A key question, however, has been whether the subsequent decline in the company's stock price was caused by the research reports. In an important decision, the U.S. Court of Appeals for the Second Circuit has affirmed the dismissal of two research analyst cases based on the plaintiffs' failure to adequately plead loss causation.
The appeal was from Judge Pollack's seminal decision in June 2003 dismissing the securities class actions brought against Merrill Lynch based on allegedly biased research reports concerning 24/7 Real Media, Inc. and Interliant, Inc. Judge Pollack found that the plaintiffs had failed to adequately allege loss causation because there was no alleged connection between the analyst reports and the companies' financial troubles or the collapse of the overall market. (See this post, among others, for a discussion of the decision.)
In Lentell v. Merrill Lynch & Co., 2005 WL 107044 (2d Cir. Jan. 20, 2005), the Second Circuit affirmed Judge Pollack's ruling. The court held that to establish loss causation, a plaintiff must allege that the subject of the misrepresentation was the cause of the actual loss suffered. In other words, the misrepresentation must have "concealed something from the market that, when disclosed, negatively affected the value of the security." In these cases, however, the court found there was "no allegation that the market reacted negatively to a corrective disclosure regarding the falsity of Merrill's 'buy' and 'accumulate' recommendations and no allegation that Merrill misstated or omitted risks that did lead to the loss." Accordingly, the plaintiffs failed to adequately plead loss causation.
The Second Circuit's decision would appear to have two potential impacts. First, it will make it difficult for the numerous other research analyst cases to go forward. The plaintiffs will need to adequately allege that either: (1) the disclosure of the false recommendations caused a stock price decline; or (2) the recommendations concealed risks about the stocks that later lead to a loss. Certain complaints, however, may satisfy these requirements (see the roundup of cases in this post). Second, the decision could affect the Supreme Court's pending ruling in the Dura loss causation case. Although the Second Circuit does not alter its previous position on loss causation (rejecting the price inflation theory), the case illustrates the serious impact that loss causation standards can have on securities fraud litigation.
Quote of note: "We are told that Merrill's 'buy' and 'accumulate' recommendations were false and misleading, and that the Firm failed to disclose conflicts of interest, salary arrangements, and collusive agreements among analysts, bankers, and 24/7 Media and Interliant. But plaintiffs nowhere explain how or to what extent those misrepresentations and omissions concealed the risk of a significant devaluation of 24/7 Media and Interliant securities. The reports indicate that 24/7 Media and Interliant were high-risk investments, a designation that specifies, inter alia, a 'high potential for price volatility,' and 'no proven track record of earnings.' And the unchallenged financial analyses presented (e.g., negative EPS ratios and consistent quarterly losses) certainly indicate weakness."
Addition: The New York Law Journal has an article (via law.com - free regist. req'd) on the decision. Thanks to all of the The 10b-5 Daily's readers who sent in the opinion.
Barred from taking discovery until after a motion to dismiss has been decided, plaintiffs frequently attempt to meet the PSLRA's heightened pleading standards for securities fraud by citing statements from confidential sources (often former or current employees of the defendant corporation). In its seminal decision in Novak v. Kasaks, the Second Circuit found that it was not necessary to name these confidential sources "provided that they are described in the complaint with sufficient particularity to support the probability that a person in the position occupied by the source would possess the information alleged."
The Third Circuit has now weighed in on the issue. In California Public Employees' Retirement System v. The Chubb Corp., 2004 WL 3015578 (3rd Cir. Dec. 30, 2004), the court adopted the Novak standard, but also stated that this standard requires "an examination of the detail provided by the confidential sources, the sources' basis of knowledge, the reliability of the sources, the corrobative nature of other facts alleged, including from other sources, the coherence and plausibility of the allegations, and similar indicia." After engaging in this rigorous examination, the court rejected most of the allegations based on confidential sources contained in the complaint. The opinion is notable for its in-depth discussion of different types of confidential sources, including former employees at various levels within Chubb's corporate organization, and what knowledge reasonably can be imputed to them.
Holding: Dismissal affirmed.
Quote of note: "Citing to a large number of varied sources may in some instance help provide particularity, as when the accounts supplied by the sources corroborate and reinforce one another. In this case, however, the underlying prerequisite - that each source is described sufficiently to support the probability that the source possesses the information alleged - is not met with respect to the overwhelming majority of Plaintiffs' sources. Cobbling together a litany of inadequate allegations does not render those allegations particularized in accordance with Rule 9(b) or the PSLRA."
One of the longest-running securities class actions has settled. The case against Cabletron Systems, Inc. was originally filed in the D. of N.H. in 1997. The plaintiffs alleged that the company hid problems with its main products and engaged in accounting fraud.
In a remarkable series of events, the case was dismissed in 1998 with leave to amend, reassigned several times after the original judge passed away, dismissed again in 2001, reinstated by the U.S. Court of Appeals for the First Circuit in 2002 (in a well-known opinion), and has since been bogged down in discovery and procedural disagreements. In the interim, Cabletron has been replaced with a successor company, Enterasys Networks, which is settling the suit.
According to Enterasys' announcement, the preliminary settlement is for $10.5 million. All but $500,000 of that amount is expected to come from the proceeds of certain insurance policies. This is the second securities class action Enterasys has settled in the last fifteen months.
The Private Securities Litigation Reform Act of 1995 requires plaintiffs alleging securities fraud to plead a "strong inference" of scienter (i.e., fraudulent intent) on the part of the defendants to survive a motion to dismiss. Exactly how to apply this standard, however, has been the subject of constant litigation. Recent notable judicial decisions have addressed, among other topics, what is necessary to adequately plead the scienter of a corporate defendant, the use of control person liability, and the role of insider stock sales in establishing a motive to commit fraud.
The author of The 10b-5 Daily, Lyle Roberts (Wilson Sonsini Goodrich & Rosati), will be chairing a Practising Law Institute telephone briefing on this topic on Thursday, January 20 at 1 p.m. ET. The panelists are Sam Rudman (Lerach Coughlin Stoia Geller Rudman & Robbins) and Bruce Carton (Executive Director, Securites Class Action Services, Institutional Shareholder Services). CLE credit is available. Click here to register.
The U.S. Court of Appeals for the Seventh Circuit is the latest court to hold that the Sarbanes-Oxley Act of 2002, which extended the statute of limitations for federal securities fraud actions, did not revive previously time-barred claims. In Foss v. Bear, Stearns & Co., Inc., 2005 WL 43724 (7th Cir. Jan 11, 2005), the court found the Second Circuit's recent decision in the Enterprise Mortgage case (posted about here) "persuasive" on this issue and noted that it had "nothing to add."
McKesson Corp. (NYSE: MCK), a San Francisco health services company, has announced the preliminary settlement of the securities class action pending against the company in the N.D. of Cal. The case was based on the discovery of accounting improprieties at HBO & Co., an Atlanta-based health-care software business that had been acquired by McKesson in January 1999. The settlement is for $960 million. According to Securities Litigation Watch, this will be the fifth largest settlement of a securities class action ever.
The Recorder has an article (via law.com - free regist. req'd) on the settlement. The McKesson securities litigation has a long history, with a number of interesting court decisions. A couple of years ago, The 10b-5 Daily posted about McKesson's attempt to file a counterclaim against former HBOC shareholders for unjust enrichment.
Oral argument in the Dura Pharmaceuticals v. Broudo case took place in the U.S. Supreme Court this morning (links to all of the main briefs can be found here). The question presented was: "Whether a securities fraud plaintiff invoking the fraud-on-the-market theory must demonstrate loss causation by pleading and proving a causal connection between the alleged fraud and the investment's subsequent decline in price."
Chief Justice Rehnquist did not attend the hearing, but reserved his right to participate in the decision. Argument was heard from counsel for Dura Pharmaceuticals, the U.S. government (in support of Dura's position), and Broudo. Here are a few notes on the main issues that were discussed:
Overall Impressions - Predicting how the Supreme Court will rule based on oral argument is a tricky business. That said, the Court appeared likely to reject the 9th Circuit's price inflation theory of loss causation. Whether the Court will attempt to lay out what a plaintiff in a fraud-on-the-market case must plead as to loss causation to survive a motion to dismiss, however, was unclear.
Dura's Position - Consistent with their briefs, Dura's counsel argued that a loss only occurs when a corrective disclosure is made. Justice Breyer posed the following hypothetical - a company says it has found gold and its stock price is $60; the company later discloses that no gold has been discovered and the stock price declines to $10; the loss is clearly $50. But what if the gold never existed but the company finds platinum and the stock price rises to $200? Are plaintiffs permitted to show that the stock price would have been $250 if the company had also found gold? Dura's counsel did not disagree that it might be possible to demonstrate loss causation under these circumstances, but argued that there would need to be a disclosure about the absence of gold.
Difference Between Dura And Government? - Justice Ginsburg, in particular, noted that there appeared to be a difference between Dura's position and the one put forward by the government, because the government allowed for the possibility that something other than a corrective disclosure might be sufficient to establish loss causation. Justice Scalia emphasized that plaintiffs simply need to show that the market knows the truth, however that truth comes to be revealed.
Government's Position - The government's counsel then argued that to establish loss causation, plaintiffs must demonstrate that the price inflation caused by any misrepresentation was removed or reduced by the dissemination of corrective information (but there is no need for a formal disclosure from the company).
Rule 8 vs. Rule 9(b) - Having established its basic position, the government's counsel found himself in the awkward position of spending most of his time defending a proposition of law that was not really briefed in the case. At least two justices, Ginsburg and Stevens, appeared to feel strongly that the pleading of loss causation is only subject to the notice pleading requirements of Fed. R. Civ. P. 8. The government's counsel countered that, as an element of fraud, loss causation must be plead with particularity pursuant to Fed. R. Civ. P. 9(b) and it was important to make an assessment about loss causation at the pleading stage of a case before defendants are forced to pay millions in discovery costs or settlement of the claims.
Need A Viable Theory of Loss? - Even if Broudo was only required to engage in notice pleading on the issue of loss causation, Justice Breyer questioned whether the complaint still needed to articulate a viable theory of loss. Broudo's counsel conceded that the complaint could have contained more on this point, but later noted that the pleading was in conformity with 9th Circuit law at the time it was filed.
When Does Loss Occur? - As expected, a large portion of the argument concerned whether the 9th Circuit's price inflation theory of loss causation (i.e., that the loss occurs, and a viable claim exists, at the time the purchaser buys the stock at an artificially inflated price) is correct. Broudo's counsel argued in favor of the 9th Circuit's position, but conceded that to show recoverable damages the plaintiffs would eventually have to establish that the inflation in the stock price was reduced or eliminated. A number of justices expressed skepticism that there could be any cause of action for fraud prior to actual damages having been suffered. Justices Souter and Scalia suggested that the inflation in the stock price simply established the limit of the potential loss, not that any loss had occurred. Justice Scalia also wondered whether the entire case was simply a "great misunderstanding," since the parties both agreed that plaintiffs would eventually have to establish that the inflation in the stock price was reduced or eliminated. Broudo's counsel noted, however, that there was also an issue over what plaintiffs needed to plead in their complaint on this issue and it may be possible for "lowered expectations" to result in stock price drops that are related to the fraud, even though the fraud is not revealed.
The PSLRA created a safe harbor for forward-looking statements to encourage companies to provide investors with information about future plans and prospects. Under the first prong of the safe harbor, a defendant is not liable with respect to any forward-looking statement if it is identified as forward-looking and is accompanied by "meaningful cautionary statements" that alert investors to the factors that could cause actual results to differ.
As discussed in a post in The 10b-5 Daily from last August entitled "The Safe Harbor May Just Be A Safe Puddle," the U.S. Court of Appeals for the Seventh Circuit has weakened the protection afforded by the safe harbor. In Asher v. Baxter International, the court found that may be impossible, on a motion to dismiss, to determine whether a company's cautionary statements are "meaningful."
The New York Law Journal has an article (via law.com - free regist. req'd) discussing the Seventh Circuit's decision and comparing it to a contrary decision issued by the Second Circuit last year. Baxter International apparently has indicated that it will appeal to the U.S. Supreme Court and the article suggests that this could be the next securities litigation issue, after loss causation in the Dura case, that the Court hears.
Eighteen former Enron directors have entered into a preliminary settlement of the securities class action claims against them for $168 million. As in the similar WorldCom settlement, Bloomberg reports that a portion of the funds ($13 million) will be paid by ten of the directors personally. The amount of the personal payments is apparently "tied to allegations of insider trading."
Quote of note: "In addition to the $168 million settlement amount, the directors agreed to pay $32 million to Enron creditors, the investors said. That money will also be paid out of the insurance policies, which total $200 million of coverage. Another $13 million of insurance proceeds will be reserved for the legal fees of directors who didn't settle, including former Enron Chairman Kenneth Lay and ex-Chief Executive Jeffrey Skilling."
The National Law Journal has a solid preview (via law.com - free regist. req'd) of the Supreme Court argument in Dura Pharmaceuticals v. Broudo. Counsel for both parties in the case, which addresses the issue of loss causation, are quoted extensively. The argument will take place next Wednesday.
More from the international front, as France joins the list of countries that may implement a class action system. The Financial Times reports that President Jacques Chirac has asked his government to propose laws that would permit "collective actions against abusive practices that have been observed in certain markets." Thanks to Adam Savett for the link.
Ten former outside directors of WorldCom have agreed to a preliminary settlement of the WorldCom securities class action claims against them. The settlement is for $54 million. Notably, $18 million of that sum will be paid personally by the directors (with the rest covered by insurance). According to an article in the Washington Post, the $18 million figure represents more than 20% of the directors' combined net worth.
Quote of note: "'This is a watershed development by imposing personal liability on corporate directors beyond the scope of insurance coverage,' said WorldCom's court-appointed corporate monitor, Richard C. Breeden, former chairman of the Securities and Exchange Commission. 'It will send a shudder through boardrooms across America and has the potential to change the rules of the game.'"
Securities litigators eagerly awaiting oral argument in Dura Pharmaceuticals v. Broudo, the loss causation case currently before the U.S. Supreme Court, will want to take a look at Dura's reply brief (this post has links to the earlier briefs). The argument will take place on January 12, 2005. Thanks to SecuritiesLawblog for the link.
The Baltimore Business Journal reports that Deloitte & Touche, along with a few other corporate and individual defendants, has been dismissed from the Royal Ahold N.V. securities litigation pending in the D. of Md. The case stems from the Dutch retailer's $1.1 billion earnings restatement last year. Deloitte & Touche served as the auditors for Royal Ahold and its U.S. subsidiaries. The court's lengthy decision can be found here.
Disclosure: The author of The 10b-5 Daily is quoted in the article.
Cornerstone Research and the Stanford Law School Securities Class Action Clearinghouse have released a report on federal securities class action filings in 2004. The findings include:
(1) Securities class action filings increased by 17% from 2003 to 2004, rising from 181 companies sued to 212 companies sued (the post-PSLRA annual average is 190 filings).
(2) The total decline in market capitalization from the beginning to the end of the purported class periods nearly tripled from $58 billion to in 2003 to $169 billion in 2004. This increase is attributable to a small number of cases with unusually large market capitalization declines.
(3) The top three circuits in terms of number of filings in 2004 were the Ninth Circuit (64 filings), the Second Circuit (45 filings), and the Eleventh Circuit (20 filings).
(4) The number of issuers sued in the technology sector nearly doubled, fueling the rise in the number of filings in the Ninth Circuit (primarily California).
The joint press release announcing the report can be found here.
The chief executive officer ("CEO") of MCG Capital Corp. ("MCG") misled his company into believing that he had an undergraduate degree in economics from Syracuse University. MCG repeated this false statement in its SEC filings. Once the CEO admitted the truth, MCG corrected its public statements and the company's stock price declined. A securities class action suit filed in the E.D. of Va. soon followed. The district court dismissed the case, finding that the CEO's educational background was immaterial as a matter of law. Plaintiffs appealed.
In Greenhouse v. MCG Capital Corp., 2004 WL 2940871 (4th Cir. Dec. 21, 2004), the U.S. Court of Appeals for the Fourth Circuit has affirmed the district court's decision. The court held that an action brought pursuant to Rule 10b-5 must "allege a fact that is both untrue and material." It follows that Rule 10b-5 "does not prohibit any misrepresentation - no matter how willful, objectionable, or flatly false - of immaterial facts, even if it induces reactions from investors that, in hindsight or otherwise, might make the misrepresentation appear material." The court went on to find that although the statements made about the CEO's educational background were clearly false, they were immaterial because there was no credible basis for believing that the CEO's lack of an undergraduate degree would have altered the "total mix" of information available to investors about the company.
Holding: Affirming dismissal.
Quote of note: "In conclusion, while we acknowledge that [the CEO's] lie is indefensible, it does not follow invariably that it is illegal. We hold that, viewed properly, it is not substantially likely that reasonable investors would devalue the stock knowing that [the CEO] skipped out on his last year at Syracuse. That is, if one imagines a parallel universe of affairs where the one and only thing different was that MCG's filings made no mention of [the CEO's] education (or, instead, said simply that he 'attended' Syracuse or 'studied economics' there), we find it incredible to believe that MCG's stock would be worth even a penny more to a reasonable investor."